Depreciation Basics for Rental Property Owners

What Is Depreciation?

Depreciation is a tax deduction that allows you to recover the cost of an income-producing asset over its useful life. For rental property owners, this means you can deduct a portion of your building's cost each year — even though the property may actually be appreciating in market value.

The IRS considers buildings to be wasting assets because they physically deteriorate over time. Depreciation compensates you for that wear and tear, reducing your taxable rental income without requiring any out-of-pocket expense. It is a paper loss — you never write a check for it, yet it lowers your tax bill dollar for dollar against your rental income.

For many rental property owners, depreciation is the single largest deduction available. On a $500,000 property with $400,000 in depreciable basis, straight-line depreciation alone generates roughly $14,545 per year in deductions. Combined with cost segregation and bonus depreciation, first-year deductions can be multiples of that figure.

How Residential Rental Depreciation Works

Residential rental property (property where 80% or more of the gross rental income comes from dwelling units) is depreciated over 27.5 years using the Modified Accelerated Cost Recovery System (MACRS) and the mid-month convention.

The formula is straightforward:

Annual depreciation = (Cost basis - Land value) / 27.5

For example, if you purchase a rental property for $400,000 and the land is valued at $100,000, your depreciable basis is $300,000. Your annual depreciation deduction is approximately $10,909.

In the first and last year of service, the mid-month convention prorates the deduction based on the month the property was placed in service. A property placed in service in March gets 9.5 months of depreciation in year one.

Cost Basis: More Than Just the Purchase Price

Your depreciable basis is not simply what you paid for the property. The IRS allows you to include certain acquisition costs:

Purchase price (minus land value)
Closing costs that are capitalized: title insurance, recording fees, transfer taxes, legal fees related to the purchase
Capital improvements made before placing the property in service: renovations, repairs to make the property rentable, appliance installations

Expenses that are not included in basis: mortgage interest, property taxes, insurance premiums, and points paid on the loan (these are deducted separately as operating expenses or itemized deductions).

Determining Land Value

Since land cannot be depreciated, accurately separating land value from building value is critical. Common methods include:

County tax assessment ratio: Most counties assess land and improvements separately. If the assessment shows 25% land and 75% improvements, you can apply that ratio to your purchase price.
Appraisal: A formal appraisal provides a defensible allocation. This is especially useful when the tax assessment seems unreasonable.
Comparable sales: In some markets, you can look at vacant land sales nearby to estimate your land component.

The IRS does not prescribe a specific method, but the allocation must be reasonable and documented. Claiming 5% land value on a beachfront property is not going to survive an audit.

What Can Be Depreciated?

Not everything associated with your rental is depreciated the same way. Different asset classes have different recovery periods:

27.5-Year Property (Building Structure)

The structural components of a residential rental: walls, roof, floors, plumbing within walls, electrical wiring within walls, HVAC ductwork, and the foundation. This is the default category — anything that is part of the building shell goes here unless it can be reclassified through cost segregation.

15-Year Property (Land Improvements)

Landscaping, driveways, parking areas, sidewalks, fencing, retaining walls, exterior lighting, swimming pools, patios, and irrigation systems. These are improvements to the land that have a determinable useful life.

7-Year Property

Office furniture, desks, specialized fixtures not inherently tied to the building, and certain security systems.

5-Year Property

Appliances (refrigerators, washers, dryers, dishwashers, stoves), carpeting, window treatments, decorative lighting fixtures, certain electrical components like dedicated outlet circuits, and electronics used for rental operations.

Land

Land is never depreciable. When you purchase a property, you must allocate the purchase price between the building and the land. Common methods include using the county tax assessment ratio or obtaining an appraisal.

Bonus Depreciation

Bonus depreciation allows you to deduct a large percentage of the cost of qualifying assets in the year they are placed in service, rather than spreading the deduction over the asset's full recovery period.

Under the One Big Beautiful Bill Act, 100% bonus depreciation was permanently restored for qualifying property. This means 5-year, 7-year, and 15-year assets placed in service can be fully expensed in year one.

Bonus depreciation applies to cost segregation components, newly purchased furnishings, appliances, and land improvements. It does not apply to the 27.5-year building structure itself.

Why This Matters for Rental Owners

Without cost segregation, a $400,000 property generates roughly $14,500 per year in depreciation. With a cost segregation study that reclassifies $100,000 into shorter-lived categories, you can deduct that $100,000 in year one via bonus depreciation — plus the straight-line depreciation on the remaining $300,000 structure. That is a first-year deduction approaching $111,000 instead of $14,500.

At a 32% marginal tax rate, the difference in year-one tax savings is roughly $30,000. That is real money back in your pocket immediately.

Section 179 Expensing

Section 179 is another first-year expensing option. It allows you to deduct the full cost of qualifying personal property (furniture, appliances, equipment) up to the annual limit ($1,250,000 for 2025) in the year it is purchased and placed in service.

Key differences from bonus depreciation:

Section 179 requires the business to have taxable income — the deduction cannot create or increase a net loss from the activity
Bonus depreciation can create or increase a loss
Section 179 can be selectively applied to specific assets; bonus depreciation is generally all-or-nothing for a given asset class

For most STR owners, bonus depreciation is more advantageous because it has no income limitation. However, Section 179 can be useful for long-term rental owners who want to selectively accelerate certain assets without triggering a large overall loss.

Depreciation Recapture

When you sell a depreciated rental property, the IRS requires you to "recapture" the depreciation you have taken (or were allowed to take) by taxing it at specific rates:

Unrecaptured Section 1250 gain (the building): Taxed at a maximum rate of 25%
Section 1245 recapture (5, 7, and 15-year property): Taxed at ordinary income rates (up to 37%)

Depreciation recapture applies regardless of whether you actually claimed depreciation — the IRS taxes the amount you were "allowed" to deduct. This is why it is always better to claim depreciation than to skip it. You pay the recapture tax either way; not claiming the deduction just means you paid more tax along the way for no benefit.

Deferring Recapture With a 1031 Exchange

You can defer recapture through a 1031 like-kind exchange, which allows you to swap one investment property for another without triggering a taxable event. The depreciation recapture obligation carries over to the replacement property — it does not disappear — but it defers the tax liability indefinitely. Many investors use sequential 1031 exchanges throughout their careers and never pay recapture during their lifetime.

At death, heirs receive a stepped-up basis, which eliminates the accumulated depreciation recapture entirely. This makes the combination of aggressive depreciation + 1031 exchanges + stepped-up basis one of the most powerful wealth-building strategies in real estate.

Common Mistakes

Not depreciating at all: Some owners skip depreciation to "save it for later." This does not work — you will owe recapture on the amount you were allowed to deduct regardless. Always take your depreciation.
Depreciating land: Land is not depreciable. Failing to allocate properly inflates your deduction and creates audit risk.
Using the wrong recovery period: Residential rental is 27.5 years. Commercial property is 39 years. Mixing these up results in incorrect deductions.
Ignoring cost segregation: Depreciating your entire property over 27.5 years leaves money on the table. A cost segregation study identifies components eligible for 5, 7, and 15-year schedules.
Starting depreciation late: Depreciation begins when the property is "placed in service" — the date it is ready and available for rent. If you bought a property in June and had it rental-ready by August, depreciation starts in August. You cannot go back and claim missed years without filing amended returns or a change in accounting method (Form 3115).

Getting Started

Use the RentalDeductions calculator to see your estimated depreciation deductions, or generate a full report that includes cost segregation analysis, bonus depreciation, and Section 179 optimization for your specific property.